ICLAS V The Regulation of Equity Crowdfunding in

ICLAS V The Regulation of Equity Crowdfunding in Malaysia Mohsin Hingun, IIUM Aiman Nariman, IIUM Fatoni University, Patani, April 18, 2016 1

Crowdfunding The New Method of Raising Funds for new businesses & start-ups 2

What is crowdfunding? • Accumulation of small investments in individual projects by large number of individuals (the “crowd”) via or with help of Internet and social networks (De Buysere et al. , 2012) • Prof. S Bradford: raising money "through relatively small contributions from a large number of people, " usually through the Internet by way of an online intermediary • Heminway & Hoffman, ("Crowdfunding involves using a web-based business enterprise to seek and obtain incremental venture funds from the public using a website. "). • “the collective effort of individuals who network and pool their money, usually via the Internet, to support efforts initiated by other people or organizations. ” 3

Crowdfunding Models Donation-based crowdfunding is a way to source money for a project by asking a large number of contributors to donate a small amount to it. 4

• Donation-based crowdfunding is a way to source money for a project by asking a large number of contributors to donate a small amount to it. • Reward-based crowdfunding involves setting varying levels of rewards that correspond to pledge amounts. A standard rewards campaign offers at least three levels of pledges/rewards. • Debt-based crowdfunding also called as microfinancing or peer-to-peer (P 2 P) lending: start-ups borrow money from a number of people online and pay them back after the project is finished. 5

• Lending Crowdfunding: allows entrepreneurs to raise funds in the form of loans that they will pay back to the lenders over a pre-determined timeline with a set interest rate • Equity Crowdfunding is a process in which people invest in an unlisted company in exchange for equitable rights in the form of shares in that company 6

Equity Crowdfunding • Equity crowdfunding enables savvy investors the chance to invest in startups, newly established or established businesses. In return for financial contributions, again relatively small, individuals can have an equity stake – entitling them to a share of revenues or profits. This form of crowdfunding is probably the newest type but also the fastest growing. Crowdcube, the world’s biggest equity crowdfunding site, grew over 500% over the past year! It is quickly attracting the attention of celebrities as well as mainstream financial professionals. 7

Equity Crowdfunding • A company raises financial capital from the crowd in exchange for an ownership stake, represented by share ownership. • Startups and other small businesses with high growth potential but lacking cash flows represent the most likely users of equity crowdfunding • These businesses remain privately held with a limited or non-existent secondary market for the widely-distributed, small equity stakes sold through crowdfunding. • However, the equity crowdfunding investor may not have any anticipation of a near-term return [ROI] 8

• • Parties to Equity Crowdfunding[ECF] Issuer: A person who is hosted on an ECF platform seeking to raise capital by offering its shares. ECF Platform: An equity crowd funding platform- electronic on the internet ECF Operator: One who operates the ECF platform- the intermediary Investors: Members of the public 9

Malaysian Legal Regime applicable to ECF 1. Ss 34 -36 A of the CMSA [ Subs 1499/2015]: • Recognition of a market operator • Its registration • Duties of the recognised market operator • Withdrawal of registration 2. SC Guidelines on Regulation of Markets under Section 34 CMSA [SC-GL/2 -2015] The Guidelines on Regulation of Markets Under Section 34 of CMSA (Guidelines) are issued by the Securities Commission (SC) pursuant to section 377 of the Capital Markets and Services Act 2007 (CMSA) read together with subdivision 4, division 2 of Part II CMSA. 10

Ss 34 -36 A CMSA • 34. (1) For the purposes of paragraph 7(1)(e), the Commission may upon application by a person, register the person as a recognized market operator subject to any terms and conditions as the Commission considers necessary. • (2) The Commission may, from time to time, add, vary, amend or revoke any terms and conditions imposed under subsection (1). 11

SC Guidelines 1. 14 These Guidelines comprise of the following parts– • (a) requirements for the registration of a REF • (b) terms and conditions and on-going obligations of a REF • (c) provisions on cessation of business, revocation of registration and review of status of a REF • (d) additional requirements applicable to a REF that is an equity crowdfunding platform • (e) application process for the registration of a REF 12

Guidelines on Regulation of Markets under Section 34 CMSA [SC-GL/2 -2015] Registered Electronic Facility • 1. 03 For the purposes of these Guidelines, an application for the registration of an electronic facility must be made by the operator of the electronic facility. • 1. 04 The operator shall be a body corporate or a limited liability partnership. • 1. 07 A person who wishes to operate, provide or maintain a stock market or a derivatives market that is an electronic facility in Malaysia must register the electronic facility as a REF with the SC. 1. 08 An electronic facility under paragraph 1. 07 means any electronic facility where the component parts when taken together, is a stock market or derivatives market. 13

Guidelines on Regulation of Markets under Section 34 CMSA [SC-GL/2 -2015] • 1. 10 An electronic facility will be considered to be operated, provided or maintained in Malaysia where the component parts of the electronic facility when taken together are physically located in Malaysia even if any of its component parts, in isolation, is located outside Malaysia. • 1. 11 An electronic facility that is located outside Malaysia will be considered as actively targeting Malaysian investors if the operator, or the operator’s representative, promotes directly or indirectly the electronic facility in Malaysia. 14

Guidelines on Regulation of Markets under Section 34 CMSA [SC-GL/2 -2015] • 1. 12 In deciding whethere is direct or indirect promotion of the electronic facility, the following may be taken into consideration by the SC– • (a) advertising the electronic facility, products or in the case of equity crowdfunding, an issuer hosted on the electronic facility, in any publication in Malaysia; or • (b) sending direct mail or e-mail to Malaysian addresses marketing or promoting the electronic facility. • 1. 13 Notwithstanding the above factors, in determining whether an electronic facility is targeted at Malaysian investors, the SC will assess all relevant facts and circumstances taking into account the protection of Malaysian investors and the integrity of Malaysian capital markets 15

Guidelines on Regulation of Markets: Registration • 3. 01 The SC may register an electronic facility as a REF, if • (a) the operator will be able to operate an orderly, fair and transparent market in relation to the securities or derivatives … • (b) the operator’s board, chief executive, and any person who is primarily responsible for the operations or financial management of the body corporate, are fit and proper and have not • (i) been convicted, whether within or outside Malaysia, of an offence involving fraud or other dishonesty or violence or the conviction of which involved a finding that he acted fraudulently or dishonestly; • ii) been convicted of an offence under the securities laws or any law outside Malaysia relating to capital market; • (iii) been subjected to any action taken by the SC under section 354, 355 or 356 of the CMSA; [ Admin and civil actions by SC] • (iv) contravened any provision made by or under any written law whether within or outside Malaysia appearing to the SC to be enacted for protecting members of the public against financial loss due to dishonesty, incompetence or malpractice … 16

• • • Guidelines on Regulation of Markets: Registration (v) engaged in any business practices appearing to the SC to be deceitful or oppressive or otherwise improper (whether unlawful or not) or which otherwise reflect discredit on his. . conducting business; (vi) engaged in or has been associated with any other business practices or otherwise conducted himself in such a way as to cast doubt on his competence and soundness of judgment; or (vii) engaged in or has been associated with any conduct that cast doubt on his ability to act in the best interest of investors, having regard to his reputation, character, financial integrity and reliability; (c) the operator will be able to manage any risk associated… (d) the operator will appoint at least one (1) responsible person in compliance with Chapter 4 [liasing with SC] (e) the operator will be able to take appropriate action against a person in breach including directing the person in breach to take any necessary remedial measure; 17

• • • Guidelines on Regulation of Markets: Registration (f) the rules of the REF make satisfactory provisions– (i) for the protection of investors and public interest; (ii) to ensure proper functioning of the market; (iii) to promote fairness and transparency; (iv) to manage any conflict of interest that may arise; (v) to promote fair treatment of its members or any person who applies for its membership; (vi) to promote fair treatment of any person who is hosted, or applies to be hosted, on its platform; (vii) to ensure proper regulation and supervision of its members, or any person utilizing or accessing its platform, including suspension and expulsion of such persons; (viii) to provide an avenue of appeal against the decision of the operator; and (g) the operator has sufficient financial, human and other resources for the operation of the REF, at all times. 18

Guidelines on Regulation of Markets: Registration Foreign Operator can be registered if: • (a) it is authorized to operate a stock market or derivatives market in a foreign jurisdiction; • (b) the operator is from a comparable jurisdiction with whom the SC has regulatory arrangements on enforcement and supervision; and (c) it is in the best interest of Malaysia to register the electronic facility as REF • ‘best interest of Malaysia’: (a) area of specialization and expertise … including the effect on productivity, transference of skills; • (b) the risk posed on the systemic stability of the capital market…; (c) the contribution towards attracting investments, enhancing market linkages and promoting vibrancy in the capital market; • (d) the ability in developing strategic or nascent sectors in the capital market; • (e) the degree and significance of participation of Malaysians in the capital market. 19

Guidelines on Regulation of Markets: Liason with SC • APPOINTMENT OF RESPONSIBLE PERSON • 4. 01 An operator must have at least one (1) responsible person. • 4. 02 A person to be appointed under paragraph 4. 01 must be the chief executive of the operator or any person who is primarily responsible for the operations and financial management, by whatever name called. • 4. 03 At all times, the responsible person must undertake the role of the main contact person for the purpose of liaising with the SC and perform any duty as may be directed by the SC. • 4. 04 Any vacancy in relation to the position of a responsible person shall be filled within 3 months from the date of the departure of the former responsible person in compliance with this chapter. 20

Guidelines on Regulation of Markets • TERMS AND CONDITIONS, DIRECTIONS AND ONGOING OBLIGATIONS Chap 5: SC’s Directions Compliance with Securities Laws, Guidelines, payment of fees, appointment of responsible person, the capital market products that may be traded on or through a REF; the services that may be offered; the requirement to notify the SC of any changes to the operator’s business; • the requirement to submit periodic reports to the SC; • the requirement to maintain relevant records; the protection of investors or the proper functioning of a REF • • • 21

Guidelines on Regulation of Markets • Continuous obligations • 6. 01 The operator’s board, /LLP partners, must: • (a) ensure the operator complies with all the requirements under these Guidelines including any direction issued or any term or condition imposed by the SC; • (b) ensure the responsible person carries out his responsibilities and duties; • (c) establish and maintain policies and procedures to: • (i) manage conflicts of interest; • (ii) monitor trading and other market activity to detect non-compliance with the securities laws or its rules; and • (iii) deal with complaints relating to the operations of 22 market or the conduct of its participants;

Guidelines on Regulation of Markets • Reporting and disclosure requirements • 7. 01 An operator must submit to the SC the following- • (a) an annual compliance report to demonstrate the operator’s compliance with any conditions imposed by the SC pursuant to the registration of the REF as well as the CMSA; • (b) if relevant, a copy of a report by the Shariah adviser certifying that its business and operations are managed in accordance with Shariah principles; and • (c) its latest audited financial statements, within 3 months after the close of each financial year or such further period that the SC may allow. 23

Guidelines on Regulation of Markets: ECF • 11. 04 All ECF operators must be locally incorporated. Obligations: (a) carry out a due diligence exercise on prospective issuers planning to use its platform; (b) monitor conduct of issuer and take action against misconduct of the issuer; (c) carry out investor education programmes; (d) ensure the issuer’s disclosure document lodged with the ECF operator is verified for accuracy and made accessible to investors through the platform; (e) inform investors of any material adverse change to the issuer’s proposal as set out under paragraph 11. 08; (f) monitor issuers to ensure that the fundraising limits imposed on the issuer are not breached; (g) monitor investors to ensure that the investment limits imposed on the investors are not breached; (h) obtain and retain the self-declared risk acknowledgement forms from the investors prior to them investing on an ECF platform; (i) have in place processes to monitor antimoney laundering requirements; and (j) ensure privacy of information is maintained in accordance with the Personal Data Protection Act 2010. 24

Guidelines on Regulation of Markets: ECF Operator 11. 06 The scope of the due diligence exercise by an ECF operator shall include taking reasonable steps to – (a) conduct background checks on the issuer to ensure fit and properness of the issuer’s board of directors, officers and controlling owner; and (b) verify the business proposition of the issuer. Operation of trust account 11. 07 The ECF Operator shall establish and maintain in a licensed institution, one or more trust account designated for the fund raised in relation to a listing on their platform and shall only release the fund to the issuer after the following conditions are met: (a) The targeted amount sought to be raised has been met; (b) There is no material adverse change relating to the offer during the offer period; and 25 (c) The cooling-off period of six (6) business days have expired.

Guidelines on Regulation of Markets: ECF Operator • 11. 10 An ECF operator must establish a framework which sets out policies and procedures to effectively and efficiently manage conflicts of interest including potential conflicts of interest which may arise in the course of the ECF operator carrying out its functions. Such conflicts must be managed in a timely manner. • 11. 11 The ECF operator, including its individual directors and shareholders, may invest in any of the issuers hosted on its platform subject to holding a maximum of 30% of controlling shares in the issuer and the ECF operator must disclose such holding to the public on its platform. • 11. 12 The ECF operator is prohibited from– • (a) providing any financial assistance to investors to invest in shares of an issuer hosted on its platform; and • (b) compensating any finder or introducer for providing the ECF operator with information about potential investors. 26

Issuers: Permitted and non-permitted Issuers 11. 13 Only locally incorporated private companies (excluding exempt private company) will be allowed to be hosted on the ECF platform. 11. 14 Entities are prohibited from raising funds through an ECF platform: (a) commercially or financially complex structures (FI) (b) public listed companies and their subsidiaries; (c) companies with no specific business plan or its business plan is to merge or acquire an unidentified entity (i. e. blind pool); (d) companies other than a microfund that propose to use the funds raised to provide loans or make investment in other entities; (e) companies with paid up share capital exceeding RM 5 million; and (f) any other type of entity that is specified by the SC 27

Guidelines on Regulation of Markets: Issuers • 11. 15 An issuer shall not be allowed to be hosted concurrently on multiple ECF platforms. • 11. 16 An ECF operator may allow for the hosting of a microfund on its platform provided that these entities– • (a) are registered with the SC as a venture capital company; • (b) have a specified investment objective; and • (c) only raise funds from sophisticated investors and angel investors. 28

Guidelines on Regulation of Markets: Issuers Limits to fund raised on an ECF Platform 11. 17 The following limit shall apply to any listing on an ECF platform- (a) An issuer can only raise up to RM 3 million within a 12 -month period, irrespective of the number of projects an issuer may seek funding for during the 12 -month period; and (b) an issuer can only utilise the ECF platform to raise a maximum amount of RM 5 million, excluding the issuer’s own capital contribution or any funding obtained through private placement exercise. 11. 18 Paragraph 11. 17 shall not apply to a microfund listed on an ECF platform. 29

Guidelines on Regulation of Markets: Issuers 11. 19: Disclosure requirements by an issuer: • information that explains the key characteristics of the company; the purpose of the listing and the targeted offering amount; the business plan of the company; and (d) financial information: • (i) for Offerings < RM 300, 000: certified financial statements/info. by the issuer’s management, if req by operator. • (ii) for Offerings RM 300, 000 – RM 500, 000: (A) Audited financial statements of the company where applicable (e. g. where the issuer has been established for at least 12 months); and (B) Where audited financial statements are unavailable (e. g. the issuer is newly established), certified financial statements/information by the issuer’s management; • (iii) for Offerings above RM 500, 000: Audited financial statements of the company 30

Guidelines on Regulation of Markets • 11. 20 An ECF operator must disclose and display prominently on its platform, any relevant information relating to ECF including: - • (a) information relating to issuer as specified under paragraph 11. 19; • (b) investor education materials and appropriate risk disclosure; • (c) information on how the platform facilitates the investor’s investment including providing communication channels to permit discussions about offerings hosted on its platform; • (d) a general risk warning in participating in ECF; • (e) information about complaints handling or dispute resolution and its procedures; and • (f) the fees, charges and other expenses that it may charge to, impose on an issuer or investor. 31

Guidelines on Regulation of Markets: Investors Types of Investors: • Retail Investors: Ordinary members of the public • Angel Investors: an investor accredited by the Malaysian Business Angels Network [MBAN: ] • Individual Angel Investor Membership is open to all Tax Residents in Malaysia and must be either: • High Net-Worth Individual with a total wealth or net personal assets of RM 3 million and above or equivalent in foreign currencies; or • High Income Earners with a gross total annual income of not less than RM 180, 000 (Ringgit Malaysia one hundred eighty thousand) in the preceding twelve (12) months or jointly with one’s spouse, a gross combined total annual income of RM 250, 000 (Ringgit Malaysia two hundred fifty) in the preceding twelve (12) months. 32

Guidelines on Regulation of Markets: ECF Investment Limit • 11. 21 A person may invest in any listing on the ECF platform subject to the following limits – • (a) sophisticated investors: No restrictions on investment amount; • (b) angel investors: A maximum of RM 500, 000 within a 12 month period; and • (c) retail investors: A maximum of RM 5, 000 per issuer with a total amount of not more than RM 50, 000 within a 12 month period. 33

Guidelines on Regulation of Markets: ECF The term “sophisticated investor” not explicitly defined in the • • 34 • • Capital Markets and Services Act 2007 (CMSA). However, Sch 6 &7 exempt the following investors and transactions from prospectus req: (a)A unit trust scheme or prescribed investment scheme; (b)A holder of a Capital Markets and Services Licence who carries on the business of dealing in securities; (c)A holder of a Capital Markets and Services Licence who carries on the business of fund management; (d)The aggregate consideration for the acquisition is not less than MYR 250, 000 or its equivalent in foreign currencies for each transaction whether such amount is paid for in cash or otherwise; (e)An individual whose total net personal assets exceed MYR 3 million or its equivalent in foreign currencies; (f)A corporation with total net assets exceeding MYR 10 million or its equivalent in foreign currencies based on the last audited accounts

Guidelines on Regulation of Markets: ECF Sophisticated Investors • (g)A licensed offshore bank under the Offshore Banking Act 1990; • (h)A licensed offshore insurer under the Offshore Insurance Act 1990; • (i)A licensed institution under the Banking and Financial Institution Act 1989 or an Islamic Bank under the Islamic Banking Act 1983; • (j)An insurance company registered under the Insurance Act 1996; • (k)A statutory body established by an Act of Parliament or an enactment of any State; and • (l)A pension fund approved by the Director General of Inland Revenue 35

Guidelines on Regulation of Markets: ECF Platforms • Press Statement, June 11, 2015: The six platforms, local and foreign, are • • • Alix Global, Ata Plus, Crowdonomic, Eureeca, Pitch. IN Propellar Crowd+. • These ECF operators were expected to commence their platforms by the end of 2015. 36

Current Status • Only 2 have just started business • Announcement of Loan Crowdfunding 37